21/94 29 November 1994 TRUSTS AND SETTLEMENTS: SIMPLIFICATION OF INCOME TAX "BENEFIT TO SETTLOR" RULES The Chancellor proposes in his Budget to simplify the rules which, in certain circumstances, treat the income of trusts and other settlements as the settlor's for tax purposes. The Chancellor's intention is to replace the present complex statutory provisions with a shorter and simpler set of rules, which will apply from 6 April 1995. DETAILS 1. The existing legislation is designed to counter tax avoidance through the use of trusts and other similar devices. The various provisions operate in a complicated, and often uncertain way. They have been introduced in a piecemeal fashion over many years; some have effectively become obsolete in the light of developments elsewhere in the tax system; there is considerable overlap; and some rules apply to only a small number of old trusts. 2. Under the Chancellor's proposals, sections 660 to 685 in Part XV of the Income and Corporation Taxes Act 1988 will be repealed and replaced with a single set of rules. These will be much shorter, simpler to understand, and of more certain application. There will be three basic charging provisions. 3. First, where the settlor (ie the person by whom the settlement is made) or the settlor's spouse has retained an interest in the settlement, income arising under the settlement will be treated as the settlor's for tax purposes. 4. Second, where the settlement is in favour of a settlor's minor unmarried child, income - and in certain circumstances capital - paid to the child is to be treated as the income of the settlor. The present rule that income of less than Pounds 100 is ignored for this purpose will be retained. 5. These two rules will be based closely on existing provisions. 6. Third, where the trustees of a settlement make a loan to the settlor or the settlor's spouse, or where either of them makes a loan to the trustees, the settlor will be charged to income tax on the annual value of the loan, which will be calculated by reference to a statutory rate of interest. This new provision will replace the existing rule under which a settlor may be charged to income tax on part or all of a loan, repayment of a loan, or other capital payment received from the trustees. NOTES FOR EDITORS 1. The legislation in Part XV of the Income and Corporation Taxes Act 1988 is designed to prevent people avoiding tax by diverting their income through settlements to someone who pays income tax at a lower rate. It operates by charging the settlor on the income in question. 2. The present rules apply where: the settlor retains an interest in the settlement. ("Retaining an interest" means that under the rules of the settlement the income or capital could be paid to the settlor or the settlor's spouse or applied for their benefit.) The income of the settlement is treated as the settlor's either for higher rate tax or for all tax purposes; the income of the settlement is paid to the settlor's minor unmarried child. Sums paid, together with capital payments to the extent that they represent undistributed income of the trust, are treated as the settlor's income for tax purposes subject to a de minimis limit of Pounds 100; the settlor or the settlor's spouse receives capital payments from a trust, including a loan or a repayment of a loan. The payments are treated as the settlor's income for tax purposes to the extent that they represent undistributed income of the trust. 3. Although the tax liability of some settlors will change under the Chancellor's proposals, the new rules are not primarily designed to alter either the extent or the amount of the tax charge. The Exchequer effect is expected to be negligible. 4. Earlier this year, the Inland Revenue invited a number of interested bodies to nominate pieces of tax legislation that they felt were unnecessarily complex. The Chancellor decided to reform the "benefit to settlor" rules in the light of the responses, which all identified those rules as in particular need of simplification.